ECONOMY-ARGENTINA: Creator of Currency Board Suggests Change

By Marcela Valente Reprint | | Print |

Marcela Valente

BUENOS AIRES, Apr 17 2001 (IPS) - Argentine Economy Minister Domingo Cavallo’s plan to introduce legislation that would eventually include the euro in the country’s currency peg has triggered a debate on the overvaluation of the peso – a taboo subject in a country with a history of hyperinflation.

The announcement confirmed the hypothesis of critics of the “convertibility law” or currency board system, which pegs the peso at par with the dollar, that the only person capable of introducing changes to the system without causing an impact on the economy was Cavallo himself.

Cavallo, who once again took up the reins of the economy ministry last month, created the currency board system in 1991 while serving as economy minister under then-president Carlos Menem (1989-99).

Cavallo’s aim now is to shore up the competitiveness of Argentine products without devaluing the peso, while attempting to avoid cutting public spending. However, many analysts say they do not yet understand how the proposal will contribute to correcting the overvaluation of the peso.

So far, no candidate with serious hopes of winning a public post in elections has dared question the currency board scheme in effect since 1991, which has earned the public’s confidence despite the fact that many political leaders have begun to see it as a “lead lifebelt.”

Ten years after the plan that curbed four-digit inflation went into effect, Cavallo announced Saturday that he was drafting a new law that would link the peso to an average of the euro and the dollar. (As of next January, the euro will be the only currency circulating in 12 of the European Union’s 15 member countries).

According to the proposed measure, once the euro has achieved parity with the dollar, the value of the peso will be determined by an average of those two currencies.

The euro has lost value against the dollar over the past two years, which means the peso is currently overvalued with respect to the EU currency. The peso is also overvalued against the Brazilian real, which has steadily depreciated since its January 1999 devaluation.

Brazil is Argentina’s main partner in the Southern Common Market (Mercosur) trade bloc, also comprised of Paraguay and Uruguay.

Analysts point out that the currency board regime would not be modified until the euro reached the same value as the dollar – a development that depends on a range of variables marking the global economy.

Cavallo’s initiative was seen as an attempt at vanquishing fears of an eventual devaluation of the peso, which have been growing since he publicly admitted that the local currency was overvalued by 20 percent, shortly after being named economy minister last month.

Analysts say the proposed legislation is aimed at justifying a series of measures the minister has adopted since March, designed to stimulate production and neutralise the adverse effects of the overvaluation of the currency, especially with respect to Brazil.

Meanwhile, he ruled out a devaluation of the peso or the “dollarisation” of the economy, measures that have been called for by various sectors.

The proposal also demonstrates that the currency board system can be flexible, by permitting the introduction of a new currency to back the peso, said Cavallo.

However, economic analysts and representatives of the business community reacted nervously to Cavallo’s initiative, which they alternately described as “unreal”, “inopportune”, “useless” and even “counter-productive.”

The secretary of Economic Policy, Adolfo Sturtzenegger, said “the idea is simply to provide the Argentine economy with a slightly more stable exchange rate with respect to the leading currencies.”

Sturtzenegger added that the proposal was to adopt “a more stable system, while maintaining the basic principles of the ‘convertibility’ regime.”

The secretary of the Argentine Industrial Union, Ignacio de Mendiguren, expressed support for the initiative, which he said would bolster the competitiveness of products exported to the EU, which as a bloc is a bigger trading partner than the United States.

But economists are wondering what will be the concrete effects of incorporating the euro to the currency peg, when such a measure will depend on an external factor – the euro’s hitting parity with the dollar.

Local economist Roberto Alemann said that if the euro were to continue recovering, as predicted, and were to reach parity with the dollar today, the peso would be even more overvalued.

Economists say the convertibility regime is compatible with strict fiscal discipline, aimed at keeping costs from being driven up by increased public spending and growing pressure from taxes, and in no way are they calling for the currency board scheme to be abandoned, especially due to the impact that could have on the country’s foreign debt.

Nearly 70 percent of Argentina’s public debt of around 140 billion dollars was contracted in dollars, as was a similar proportion of the private sector debt – which makes it impossible to devalue the peso without triggering major political, economic and financial costs.

Economist Carlos Pérez, with Fundación Capital, a local think- tank, said Cavallo’s proposal was acceptable as a transition to a system of a free-floating currency, like those of Brazil, Chile or Mexico. But he said he had doubts regarding the implementation of the initiative.

Pérez said it was odd to have to wait for the euro to reach parity with the dollar, instead of setting a target involving an aspect of domestic policy, such as balancing the public accounts.

For his part, Roque Fernández, who served as economy minister in the last stretch of the Menem administration, flatly rejected the proposal, which he said would change “absolutely nothing.”

Alemann, meanwhile, described the initiative as “counter- productive,” saying it could trigger a run on the dollar in Argentina, which would drive up interest rates in pesos, just when producers are in need of cheap credit.

Daniel Heymann, an economist with the Economic Commission for Latin America and the Caribbean (ECLAC), said that pegging the peso against a “basket” of currencies would “do nothing for Cavallo, except to explode the myth of the ‘sacred’ peg to the dollar, curb dollarisation, and open up a financial market in another currency.”